Why is the Economy Doing Poorly?

First, a large fiscal stimulus addresses factor #8 but fares poorly in alleviating the other problems. Of course it may give a band-aid for #5 or #6 and you can tell other stories but we are in a multi-factor depression.

Second, forecasting will prove very difficult.

On the first point, I am planning a longer post on the topic of a recession (or a depression, if we go with Tyler's view) as an information problem. That is, fundamentally, people do not know how to invest for the long term. It could take a long time for them to figure it out.

I think that when the economy does come back, it will come back strongly. There will be pent-up demand, because of the consumer spending that is being foregone during the downturn. But whether this resurgence occurs in 2009 or closer to 2019 is difficult to forecast.

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Arnold Kling wrote: “I think that when the economy does come back, it will come back strongly. There will be pent-up demand, because of the consumer spending that is being foregone during the downturn. But whether this resurgence occurs in 2009 or closer to 2019 is difficult to forecast.”

The economy will “come back” when demand returns. This in turn can be expected when prices and value are right for consumers and when the burden imposed on the private economy by federal-government spending is either reduced or stabilized such that it is at least predictable. The latter will allow investors to better assess risk.

Do you see a permanent increase in the savings rate? It seems to me that that is universally expected.

If so, isn't the magnitude of this shift towards savings is going to be an important determinant of how much demand, exactly, is gonig to be "pent-up". It's possible it won't be much, especially if the recovery happens closer to 2009 than 2019.

I'm sure this question was addressed to Prof. Kling, but I will comment anyway. IMHO an increase in the savings rate - forced or voluntary - would signal a departure from our culture of debt. It might not mean a return to the go-go days of the recent past, but it would put each of us, and hence "the economy," on a much more sustainable footing. As we all know, debt eventually comes due.

I'm not sure this is an information problem. Is it that prospective investors can't see a clear path for investment, or rather that none exists? (forgive me for being metaphysical)

If the first is true, I would agree that the problem is one of information. If the second is true, this is not a problem of information, it is a failing of policy to further sustainability and to create or safeguard opportunity, and/or a result of unreasonable expectations. Those can take a considerable amount of time to remedy.

How exactly is it that you see consumer spending being "foregone"? Isn't it more the case that consumers are desperately trying to pay off their massive and untenable debts in the face of greatly increased risk of unemployment and while suffering from the wealth effects of a catastrophic decline in asset values?

Where is this pent-up demand you talk about? Of what do people need more? Is there a housing shortage? Automobiles? Computers? Credit default swaps? What, exactly?

"Why We Are In A Depression, Simplified For Tyler Cowen and Other George Mason Professors Who Should Darn Well Know Better"

#1 For many years there was a massive and artificial increase in the supply of money and credit, brought about by low-to-negative real interest rates and astronomical over-leveraging by governments, banking institutions, and businesses, which led, as inflation always does, to severe mal- and over-investment that was only justifiable given the assumption that the supply of money and credit could increase forever with no negative consequences.

Where is this pent-up demand you talk about? Of what do people need more?

Strictly speaking, people don't need more, they need new. New computers become two year old computers become 6 year old computers become big plastic bricks when hard drive fails. 3 year old cars become 5 or 9 year old cars with dodgy transmissions. Shirts fray, socks hole, refrigerators rattle, roofs leak. In the normal course of events, a lot of "consumption" is of objects which are, essentially, household capital. After some amount of time, most of these things start creating extra aggravation and cost for the owner, at which time the owner would normally buy a new one. In bad times, the owner may 'eat' the extra aggravation and repair costs, but ultimately they will want to get a new one once they are 'on their feet' financially.

For example, if you normally buy a new car every five years, you might defer buying a new car for a year or two, and just nurse the old one along a couple of years longer. If Jim down the street would normally be shopping for a new car next year to replace his current heap, Jim and you will both be looking for a car when the economy recovers next year. Had you bought 'on cycle', only Jim would be looking, since you would already have your new car. That is pent-up demand. The same story can be told about all sorts of capital stock with short to medium depreciation time-lines.

There are also true consumption goods that may accrue 'pent-up' demand - "We skipped our vacation the last two years, now that we are flush, let's take two weeks and hit Europe" or "It's been ages since we went to that nice restaurant downtown".

I would argue that our problems are no more complicated than the cumulative affects of successive stimulus packages over the years. When you consider that a stimulus is nothing more than a package of incentives to increase spending, is it surprising that the increased spending comes at the expense of savings? This can have short term advantages, but also has long term consequences. If there is never a time to recoup the savings, subsequent stimuli must become larger and larger to compensate for the weakened condition of the economy. For the last 50 years, I have seen nothing but stimulus and the size appears to have grown to over $1 trillion. That scares me.

In short, our economy is doing poorly because the American consumer is tapped out and banks are overleveraged, all because we have had one stimulus after the other to smooth volatility out of our economy. We can talk about credit default swaps, regulations, housing bubbles or anything else; but the real problem comes down to too much debt and not enough savings. It has taken us 50 years to get where we are and there are no painless ways to fix it. But it is not that complicated either. The last thing we need is a trillion dollar stimulus on top of the mess we have already created.

In short, our economy is doing poorly because the American consumer is tapped out and banks are overleveraged, all because we have had one stimulus after the other to smooth volatility out of our economy.

True, but we can smooth volatility (a good goal) without such humongous debt (an economic albatross). The trick is to be counter-cyclical on BOTH sides of the cycle. Instead, we spend to get out of the ditch and fail to tax once we've extricated ourselves. We try to grow faster than we are capable of growing. If we would balance growth with _truly_ counter-cyclical fiscal policy, there could be far less volatility while making long-run investment prospects more attractive.

I agree completely. All we need to do in order to make this happen is:

Develop a better understanding of economics so we know what indicators to track and then manage the economy to those indicators. In other words, the government needs to use the kind of accounting that businesses use, not the abomination it has today.

Elect politicians that are willing to show leadership and put the good of the country ahead of their own political careers.

Listen only to economists that truly understand macro-economics and who are willing to take politicians to task when they get out of line.

Learn to be rational voters.

It is not really that much, but would you like to place a bet on whether or not we will ever see this happen?

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